Do litigation funders need an Australian Financial Services licence to do business? International Litigation Partners Pte Ltd v Chameleon Mining NL and Anor  276 ALR 138
The New South Wales Court of Appeal has delivered the most recent challenge to the Australian litigation funding industry, finding that a funding agreement was unenforceable on the basis that the litigation funder was dealing in a “financial product” without an Australian Financial Services (AFS) licence.
On 28 October 2008, Chameleon Mining NL (Chameleon) entered into a litigation funding agreement with a Singaporean litigation funder, International Litigation Partners Pte Limited (ILP), in respect of proceedings commenced in the Federal Court of Australia by Chameleon against Murchison Metals Limited and others. ILP was entitled under the funding agreement to the repayment of its legal costs and the payment of a percentage of the proceeds from the litigation. The funding agreement also gave ILP the right to a multi-million dollar Early Termination Fee in the event of termination.
Following a change in control in Chameleon resulting from a merger, Chameleon purported to rescind the funding agreement on the basis that, contrary to the Corporations Act 2001 (Cth), ILP was providing a financial service without an AFS licence. The impact of this challenge was that if this rescission was effective, the contract with ILP would be unenforceable and ILP would not be able to recover the Early Termination Fee or any other benefit under the funding agreement.
Decision at First Instance
Hammerschlag J rejected the proposition that the funding agreement was a “financial product” issued by a non-licensee and concluded that ILP was entitled to the Early Termination Fee.
Court of Appeal
The Court of Appeal, in determining whether the funding agreement was a “financial product”, was required to resolve whether the funding agreement was a facility through which Chameleon “managed financial risk” as required by section 763A(1) of the Corporations Act. At trial, Hammerschlag J had found that while the funding agreement minimised Chameleon’s defence costs enabling it to pursue Murchison, on no realistic view could it be said that the funding agreement was a facility through which Chameleon managed its financial risk.
On appeal, Chameleon submitted that his Honour wrongly confined attention to the payment of Chameleon’s defence costs without reference to the risk of an adverse costs order or the risk that the proceedings could not go ahead without the provision by Chameleon of security for costs, both of which also featured in the funding agreement.
The Court of Appeal unanimously held that the Funding Agreement was a “financial product”. This Court, however, was divided as to whether the exception contained in section 763E of the Corporations Act applied. This exception permits dealing without an AFS licence where managing financial risk was not the main purpose of the “financial product”. The majority concluded that managing risk was the main purpose of the facility while Hodgson JA found that this aspect was incidental to the main purpose, which was the provision of funding.
The result was that ILP was found to have provided “financial services” without an AFS licence contrary to the Corporations Act which meant that the funding agreement could be rescinded by Chameleon.
High Court - special leave
The High Court has granted special leave to ILP to appeal this decision. During the Special Leave Application, Gummow J observed that the question of licensing litigation funders was an important one that needed to be addressed.
The litigation funding industry will be watching closely this High Court appeal which is expected to take place this year. The Australian Securities and Investments Commission (ASIC) has, since the Court of Appeal judgment, issued class order 11/555 which extends class order 10/333 to exempt all litigation funding arrangements, including single member arrangements, from the requirement to hold an AFS licence.
The Federal Government has also released details of a proposed Corporations Amendment Regulation which, amongst other things, seeks to carve out funded class actions from the definition of a “financial product” in the Corporations Act. Thus it appears that whatever the outcome of the High Court appeal, litigation funders will not in future require AFS licences as the issue is being dealt with by ASIC and the Federal Government.
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Ontario Court of Appeal releases judgment on duty to defend. Hector v Piazza 2012 ONCA 26
The Ontario Court of Appeal’s decision in Hector v Piazza, 2012 ONCA 26 reminds insurers that they must pay careful attention to the wording of exclusionary clauses, which will be strictly construed against the insurer even where industry understanding of the purpose of a particular type of policy suggests a different result.
Piazza purchased and renovated an apartment building, then sold it to Hector. Hector later sued Piazza and others for negligent construction. Piazza was insured under a Comprehensive General Liability (CGL) policy that applied to the property. The insurer denied coverage and any duty to defend based on a clause in the policy that excluded:
- property damage to
- property owned or occupied by or rented to the Insured
Piazza named the insurer as a third party and brought a motion for an order against it declaring that it was obliged to defend him. The motions judge held that the wording of the exclusionary clause was ambiguous and, as a result, the insurer’s duty to defend was triggered.
The sole issue on appeal was whether the motions judge correctly interpreted the exclusion in the CGL policy. If the word “owned” referred only to the past tense, the exclusion would apply, since the insured had clearly owned the property in the past. If, however, as held by the motions judge, the word “owned” could refer to the present or to the past tense, the policy could not be said to “clearly and unambiguously” exclude coverage, since the property was no longer owned by the insured at the time the claim arose.
The Court of Appeal held that grammatically, “owned” could refer to property that was currently owned or was previously owned by the insured. As a result, the policy did not clearly and unambiguously exclude coverage, and the duty to defend was triggered.
Although an insurer’s duty to defend is often broader than its duty to indemnify, in that “the mere possibility that a claim falling within the policy may succeed will suffice” to trigger the duty, the decision in Hector v Piazza is relevant to both duties.
In drafting exclusionary clauses for CGL policies, if an insurer wishes to exclude coverage for property that is or has been owned or occupied or rented to the insured either in the present or in the past, it must state so explicitly. Hector v Piazza makes it clear that an insurer cannot rely on the argument that because a CGL policy is intended to insure against third-party liability and it is not intended to respond to first-party claims, an exclusion for property “owned” by the insured only has meaning if interpreted as referring to the past.
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Hobbins v Royal Skandia Life Assurance Ltd  HKCFI 10 in the context of the UK Bribery Act
In Jeremy Paul Egerton Hobbins v Royal Skandia Life Assurance Ltd and others  HKCFI 10, the High Court of Hong Kong confirmed that commission paid to an insurance broker by an insurer does not constitute an illegal secret profit unless it is in excess of what is normally paid within the insurance market. This, according to Reyes J, represents the long-settled common law position and is more than just a customary practice within the insurance brokerage industry. The Hong Kong insurance market has welcomed the judgment, which, amongst other things, removes any doubt as to whether insurance broker commission is akin to a bribe and whether agents have an obligation to fully disclose any commissions received.
Mr Hobbins purchased numerous Investment-Linked Assurance Scheme (ILAS) products from Skandia and other insurers via Clearwater. When the ILAS products did not perform according to Hobbins’ expectation, he took legal action against Skandia and Clearwater, in order to set aside the ILAS contracts and recover his investment. One of Hobbins’ allegations was that the ILAS contracts were illegal by reason of section 9 of the Prevention of Bribery Ordinance (PBO), in that Skandia without lawful authority or reasonable excuse rewarded Clearwater for introducing him as their ILAS product client. On this basis, Hobbins claimed that the ILAS contracts were void or unenforceable. Reyes J stated that according to a long line of judicial pronouncements stretching from the nineteenth century to the present, there is “lawful authority” for the commercial practice, under which an insurance broker acts as an agent of the insured and not of the insurance company, and it has long been settled that commission paid to an insurance broker by an insurer is not illegal unless it exceeds what is normally paid within the market. However, Hobbins’ Counsel sought to argue that the fact that commission payment might be customary is not a defence pursuant to section 19 of the PBO. To that, Reyes J said there was more than just a customary practice within the insurance brokerage industry and the practice of commission payment has been validated by over a century of judicial authority. His Lordship added that the practice of insurers paying commission to insurance brokers may or may not be unsound and ought possibly to be strictly regulated or even prohibited altogether. However, that was a question of policy for the legislature to tackle.
Hobbins v Skandia has caught the attention of insurance market players overseas including the United Kingdom, where the Bribery Act 2010 came into force on 1 July 2011 and applies to anyone who has a “close connection” to the UK. On 9 February 2012, Lloyd’s of London issued a market bulletin (Y4561), which gave further guidance on the disclosure of the remuneration of intermediaries in Hong Kong in the light of the High Court decision.
Under the UK Bribery Act, there are four statutory offences, of which two are general criminal offences covering the act of bribing someone and being bribed. The offence of bribing someone means offering, promising or giving a financial or other advantage to another person with the intention of inducing that person improperly to perform a relevant function or activities, or to reward them for doing so. The offence of being bribed means requesting, agreeing to receive or accepting a financial or other advantage to perform a relevant function or activity improperly (although the function or activity does not necessarily need to be performed by the person taking the bribe). It is in the context of these two general criminal offences that issues regarding the legality of commission payments arise.
As recognised by Reyes J in Hobbins v Skandia, commission is not generally a bribe. However, it automatically creates a potential conflict of interest between the broker and the insured (being its principal) in the sense that the former naturally wishes to obtain the highest commission possible and the latter wishes to obtain the lowest possible premium. It would be less of a problem if the insured is informed that commission is to be paid to the broker and the commission is at the normal market rate. The conflict between the broker and the insured will be more acute if the broker is remunerated by “contingent commission”, in which case the rate of commission increases in line with the amount of business the broker introduces to the insurer. The broker would have a strong incentive to recommend the insurer to its client even if a more suitable policy is available with another insurer. The first-mentioned insurer could be said to be paying a bribe with the intention of inducing the broker to improperly perform their duties to the insured (which include the duty to act in the best interests of the insured) with the broker accepting a bribe for improper performance.
On 22 February 2012, Lloyd’s of London issued another market bulletin (Y4567) to address the issues arising out of commission payments to brokers and the UK Bribery Act. The bulletin confirmed Lloyd’s view that commission at the normal market rate is compliant with the Act. However, commissions linked to the volume or profitability of the business (i.e. contingent commissions) are very high risk, and Lloyd’s insurers must not pay such commissions. The bulletin also addressed additional payments to brokers. It stated that it is important that an insurer agreeing to additional payments satisfies itself that the payment is appropriate rather than relying on the fact that other insurers may have agreed to enter into the same or a similar arrangement. Guidelines were given to assist Lloyd’s insurers in deciding whether they should agree to additional payments.
Whilst the High Court in Hobbs v Skandia confirmed that commission payments to brokers are generally not a bribe, it is important to keep an eye on the evolution of market practice in the UK in light of the UK Bribery Act.
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The due diligence proviso - is simple negligence enough for underwriters? Sealion Shipping Ltd and another v. Valiant Insurance Co (The Toisa Pisces)  EWHC 50 (Comm)
The English Commercial Court recently decided an important marine insurance question relating to the “due diligence” proviso in the Inchmaree clause (found in named perils wordings, including ITC-Hulls (01/10/83)). The Inchmaree perils - including, notably, “negligence of master officers crew or pilots” - are subject to the proviso that the loss “has not resulted from want of due diligence by the Assured, Owners or Managers”.
Toisa Pisces was insured against loss of hire. A claim was brought following a breakdown of the port-stern azimuth thruster in 2009. The claim was for 30 days’ hire, at US$ 70,000 per day. The cover required the operation of an insured peril under ITC-Hulls (01/10/83).
Underwriters argued that the assured had failed to exercise due diligence. They alleged that the assured should (and would) have avoided the 2009 breakdown by inspecting and modifying the port-stern thruster following the breakdown of the starboard-stern thruster in 2004. Underwriters did not dispute that they had the burden of proving a lack of due diligence and causation - this view being supported in the latest edition of Arnould’s Law of Marine Insurance and Average.
The judge noted that the true meaning of the proviso was “an unresolved issue of English law”. He considered two questions: (i) what amounted to a failure of due diligence - recklessness or negligence? and (ii) who must have failed? On the second question, it was common ground that the failure must be the assured’s - someone suitably senior within the assured’s organisation. In the present case, this was the assured’s onshore technical manager.
On the first question, the assured invoked the usual English insurance law position, namely that the contribution of the assured’s negligence to a loss is generally disregarded - negligent accidents being precisely the reason why insurance is purchased. The assured argued that “due diligence” should be treated the same as obligations to take “reasonable precautions” in property policies, the courts having held that the recklessness of the assured is required to breach such clauses.
Underwriters distinguished marine and non-marine insurance, arguing that in the context of the former “want of due diligence” means a lack of reasonable care. The judge agreed, holding that the proviso excludes, narrowly, only the negligence of the assured, with the negligence of others - the master, officers, crew, etc - being expressly covered. The due diligence proviso thereby “defin[ed] the scope of the indemnity”.
Underwriters may welcome this construction, under which, while they may have to prove causative negligence by the assured at a senior level, they do not need to go so far as to establish recklessness.
This article first appeared in Insurance Day
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